FINL: Clarity on Positive Trends

As a follow-up to our initial thoughts this morning, there are several noteworthy read-throughs embedded in FINL’s Q1 results from this morning’s call:

The strength in footwear – particularly running was impressive. Despite basketball and athletic casual footwear comps down double-digits, footwear comps overall were up 12%. This implies running was ‘running’ at a high-teen to 20%+ rate through Q1.

Apparel underperformed the rest of the portfolio down LSD with a particular weakness in basics. Given the inherent challenge in trying to differentiate basketball short and t-shirts and to compete with volume based value players, management made it clear that a shift is underway towards more performance product. Branded business with NKE and The North Face stands to benefit. Overall this confirms our belief that there are still opportunities for mall-based footwear retailers to sell performance apparel alongside technical footwear. The good news here is that price points on branded, performance goods are measurably higher than the basics they replace.

Inventory management remains a key element to the company’s ability to maintain its impressive sales/inventory spread well above peers. It was noted that improving turns remains a key focus, but there were probably some areas where orders could have been bigger to meet demand. Importantly, there’s a divergence within consolidated inventory whereby the company is continuing to aggressively reduce aged/underperforming inventory while at the same time building inventory in key categories i.e. running and toning. It was suggested that investments in inventory would accelerate heading into BTS relative to recent quarters. Overall, based on inventory levels from the two largest mall-based players, there is little concern that promotional activity is about to increase.

The outlook for net store growth this year improved since last quarter due to landlords increasing willingness to negotiate. While maintaining 8-10 store openings, the company cut the number of closings in half to 10-15 from 20-30. With 200bps of occupancy cost benefits realized in Q1 and approximately 30% of the store base up for some kind of lease action this year, there’s upside to management’s expectation for a 30-40bps annual positive contribution to gross margins.

Lastly, traffic continues to be inconsistent– in fact management alluded to this volatility at least a handful of times on the call. While truly a small sample, the latest read on traffic in June is positive. In looking back over monthly trends, traffic was positive in March and then down a bit in both April and May - so far in June traffic is up 2%. Perhaps just a sign of comping last year’s rebate checks, we struggle to view a positive early read on traffic as anything other than just that – positive.

With an even more favorable quarter ahead for FINL in Q2, coupled with further gains in sales productivity, product margin, occupancy cost and e-commerce, our view is that the company is on track to exceed recent peak margins of 8.3%. As a leading athletic footwear retailer, FINL is one of the most direct ways to play the multi-year trend underway in the athletic footwear space. We continue to believe that this is not a zero sum game and that there is more than one investible opportunity to capture the athletic cycle tailwind. Importantly, Finish Line’s success has little bearing on our bullish outlook for Foot Locker. We remain comfortable with our positive bias on both names following these results.

Below is additional color from the Q&A of today’s call:

Q&A:

Pricing - Vendor pass-throughs:

Vendors not pushing through price increases above and beyond expectations

Product in the $115 zone from SKX well received

SG&A Control - Labor Management/Commission Program:

Store labor costs for Q1 were flat in $$

Evaluating commissions program in a couple of markets and will be expanding to add'l mkts throughout the year

Store labor tool schedules labor according to traffic

Mgmt comfortable with LSD decline in SG&A over the balance of the year, 5%+ sounds aggressive

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